Tom Wald, CFA®, Chief Investment Officer, Transamerica Asset Management, Inc.
In this article we review:
Our recently revised year-end 2024 forecasts on the federal funds rate and the 10-year Treasury yield
The March consumer price index (CPI) report that we believe likely confirms extended timing on when the Fed will reduce rates and by how much this year
Recent economic data continuing to exhibit strength and not being conducive to imminent Fed rate cuts
Our view on the future slope of the Treasury bond yield curve and how it might impact longer-term interest rates
Based on strengthening economic data and inflation reports, we are updating our year-end 2024 targets for the federal funds rate and 10-year U.S. Treasury yield. Accordingly, we now believe the Fed is likely to reduce the fed funds rate through two, quarter-point rate cuts occurring in the fourth quarter and concluding the year at a target range of 4.75%–5.00%. During this time, we also expect the yield curve to fully flatten, and therefore we see the year ending with a 10-year Treasury yield also at approximately 4.75%.
In making these forecast updates, we emphasize the following points:
Progress on inflation has slowed. Following a rapid descent in the rate of inflation from its peak 2022 levels into the start of this year, we have now incurred three consecutive months of stalling progress. The latest CPI report for March displayed a year-over-year headline increase of 3.5% and 3.8% on its core (ex-food and energy) reading. This represents a stagnant short-term trend for these two measures, which concluded last year at 3.4% and 3.9% respectively, providing the Fed with limited rationale to reduce rates in the upcoming months.
Strong economic data continues. The March nonfarm payroll report displaying 303,000 new jobs added to the economy also presents a profile of economic strength not currently conducive to imminent Fed rate cuts. These recent employment gains are likely to solidify consumer spending activity over the next few months, providing the Fed with no real sense of urgency as it awaits further inflation data. In addition, tracking estimates for recently concluded 1Q gross domestic product infer a continuation of positive growth, as seen in the Atlanta Fed’s current estimate of 2.5% growth.
While timing is now extended, rate cuts still appear to be on the horizon. We currently lean toward the Fed reducing rates in 4Q with two, quarter-point rate cuts perhaps in November and December, reflecting an objective of normalizing interest rates while doing so with the prospect of lower inflation rates at that time.
Yield curve dis-inversion likely to impact longer-term rates. In assessing longer-term interest rates, it is important to consider what we believe will be an upcoming flattening of the Treasury bond yield curve. The 3-month to 10-year yield curve has been mired in an inverted slope (short-term rates higher than long-term rates) for 18 months, ranking it close to the longest inverted curve in history. Hence, we believe the probabilities are strong the curve will fully flatten by year-end with the 10-year Treasury yield at or close to the lower bound fed funds rate at approximately 4.75%.
In summary, we believe it is likely Fed Chair Jay Powell and his fellow Fed members recognize the ultimate need to reduce the current fed funds target range but, given recent inflation reports of stalling progress, are now looking for a more opportune time to do so. Thus, all considered, we now see a greater likelihood of two rate cuts occurring in 4Q of this year concluding with a fed funds target range of 4.75%–5.00%. With this we see the 3-month to 10-year yield curve dis-inverting to a flat slope by year-end, likely resulting in a 10-year U.S. Treasury rate also at 4.75%. Given this environment, we see the opportunity for bond investors to lock in recently elevated yields on investment-grade bonds across the short to intermediate portions of the yield curve.
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The 10-Year U.S. Treasury bond is a U.S. Treasury debt obligation that has a maturity of 10 years.
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Transamerica Asset Management, Inc., (TAM) is an SEC-registered investment adviser that provides asset management, fund administration, and shareholder services for institutional and retail clients. The funds advised and sponsored by TAM include Transamerica Funds and Transamerica Series Trust. Transamerica Funds and Transamerica Series Trust are distributed by Transamerica Capital, Inc., (TCI), member FINRA. TAM is an indirect wholly owned subsidiary of Aegon Ltd., an international life insurance, pension, and asset management company.
